Self-Discovery in a Development Strategy for El Salvador
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Econom�a 6.1 (2005) 43-101

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Self-Discovery in a Development Strategy for El Salvador


El Salvador is a star reformer. After the civil war of the 1980s, the country was able to adopt important political and institutional reforms. These included the incorporation of all political groups into the electoral process, the adoption of a new constitution, the elimination of the military police, the creation of a civilian police with members from both sides of the war, and the adoption of rules to strengthen the independence of the judiciary. On the economic front, the country consolidated its fiscal position, modernized its tax system, liberalized trade and banking, improved the regulation and supervision of its financial system, privatized most state productive assets including energy and telecommunications, and reformed its social security system in line with the Chilean model. It also expanded and granted local autonomy to the school system through the Community-Managed Schools Program (EDUCO). Finally, El Salvador dollarized its financial system in November 2000. Given the investment-grade rating earned by the country, domestic money market rates have converged to U.S. levels.

Unfortunately, El Salvador is not a star performer. Standard theory would predict that such an improvement in the institutional and regulatory environment should be followed by convergence to a higher income level. Instead, after an initial period of recovery that lasted until 1997, real gross national income per capita stagnated at levels comparable to those achieved by the country in the late 1970s. Its income relative to the United States has not recovered from the fall associated with the civil war and is just over half the ratio achieved in the late 1970s (see figure 1).

El Salvador is not alone in finding that reform efforts have had smaller-than-expected growth effects. With the exception of Chile, the effects of reform on [End Page 43] growth throughout Latin America have been smaller than the initial estimates carried out in the mid-1990s.1 In this context, El Salvador is an interesting case, since it has been particularly effective in applying wide-ranging reforms.

 Absolute and Relative per Capita Income, 1975�2003a
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Figure 1
Absolute and Relative per Capita Income, 1975-2003

This paper explores why these reforms have failed to produce more growth and what can be done about it.2 We begin by placing the economic choices faced by the incoming Salvadoran administration in a regional and historical [End Page 44] perspective. The late 1980s and early 1990s in Latin America were preceded by a decade of stagnation, but coincided with a time of unusual confidence in the future. The collapse of communism, the failure of many interventionist policies in Latin America in the 1980s, and Chile's success gave governments a clear idea of the road they wanted to leave and the road they wanted to take. Inadequate past performance and consensus on the road ahead led to a forceful policy agenda.

El Salvador's 2004 election took place at an uncertain time along both dimensions. The recent Salvadoran performance has not been stellar. Growth over the previous five years declined significantly relative to the quick pace of the early and mid-1990s and barely kept pace with a growing population, meaning that income per capita stagnated (figure 1). Incomes in rural areas declined, and nontraditional export growth, while still important, remained limited to the maquila, or in-bond garment sector, which now faces serious international headwinds.

But this performance is not without external explanations. Hurricane Mitch, the two 2001 earthquakes, the collapse in the price of coffee, the financial contagion induced by the Russian crisis, and the 2001­03 global recession represented a series of negative shocks. The country was able to deal with this adverse context without suffering a derailment of the development process.3 This is not a minor feat compared with the performance of countries such as Argentina, Colombia, Ecuador, Uruguay, and Venezuela, where real income collapses did take place.

The recent intellectual environment is also less self-assured than it was in the early...